Old National Bancorp (ONB) 2005 Q3 法說會逐字稿

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  • Operator

  • Good day and welcome to the Old National Bancorp third-quarter earnings conference call. This call is being recorded and has been made accessible to the public in accordance with the SEC Regulation FD. The call, along with the corresponding presentation slides will be archived for 12 months on the shareholders relations page at www.oldnational.com. A replay of the call will be available at beginning at 5:30 p.m. central time today through November 10. To access the replay dial 1-888-203-1112 confirmation code 8459444.

  • Those participating today will be analyst and members of the financial community. At this time, all participants are in a listen-only mode. Then we will hold a question-and-answer session and instructions will follow at that time.

  • With us today is Old National Bancorp's President and Chief Executive Officer, Bob Jones; the Chief Financial Officer, Chris Wolking; the Chief Credit Officer, Daryl Moore; the Treasurer, Jim Ryan; and the Vice President of Investor Relations, Lynell Walton.

  • At this time the call will be turned over to Ms. Walton for opening remarks.

  • - VP of IR

  • Thank you. Again I'd like to welcome everyone to our call today.

  • If you can turn to slide 3, which is our standard forward-looking statement. Let me remind that you today's call -- during today's call, management will be making certain forward-looking statements regarding future events. These statements -- for these statements Old National proclaims the protection of Safe Harbor of forward-looking statements under the Private Securities and Litigation Reform Act of 1995.

  • Turn to slide 4, that's our agenda that we will be covering today. And, again, throughout our presentation, we will be touching on all three of our strategic imperatives to strengthen our risk profiles, enhance management disciplines, and achieve consistent quality earnings. We will begin this by having Chris Wolking, our CFO discuss earnings and the financial impact of the strategic initiatives that have occurred during the quarter.

  • We will then have a more in-depth look at the margin given by our Treasurer, Jim Ryan, and he will also discuss some strategic initiatives that are under way to improve our margin. Daryl Moore will then give a discussion on credit, giving some more color on the composition of nonaccruals and problem loans. And finally Bob Jones, our CEO will give us an update on our financial targets that we set in November of 2004 where we stand on those today, and also an earnings outlook for the remainder of '05 and for next year.

  • With that, I will turn the telephone call over to Chris Wolking.

  • - EVP & CFO

  • Thanks, Lynell and thank you for joining us for the third-quarter conference call. I am pleased to report another good quarter for Old National Bancorp. Earnings from continuing operations were $0.34 per share for the third quarter, up 30% over our third-quarter earnings for 2004 and up almost 10% over our 2005 second-quarter earnings.

  • I am equally pleased to report that we have completed the sales of several assets that we had previously identified to you as inconsistent with our strategic objectives. We closed on the sales of St. Louis-based JW Terrill Insurance Agency and Cincinnati-based Fund Evaluation Group in the third quarter.

  • Also in the quarter, we sold our portfolio of mortgage servicing rights. And finally, we closed on the sale of five branches in the Clarksville, Tennessee market early in October. Third-quarter was very busy for us, and I would like to publicly thank the Old National associates who contributed to our successful quarter, particularly those who worked so hard on the sales that I just listed.

  • On slide 8, I've noted the major balance sheet impact of our divestitures. Consistent with our strategic imperatives to improve our discipline around the management and allocation of the Company's capital, the sales of FEG and Terrill allowed us to eliminate over $48 million of goodwill and intangibles. Also, selling the mortgage servicing eliminated $14.1 million of, what I term, marginal assets from our balance sheet.

  • These transactions were key to our ability to continue to buy back shares during the quarter. We bought back nearly 1 million shares during the quarter and yet we were able to improve our tangible equities asset ratio by 27 basis points to 6.38%. We are now virtually squarely in the middle of range of our tangible equity ratio target of 6% to 7%.

  • On slide 9, I identified another benefit to our divestitures. By selling FEG and Terrill and eliminating the corresponding goodwill associated with these companies and selling our mortgage servicing, we removed sources of potential earnings volatility. This, of course, is consistent with our strategic imperative to deliver consistent quality earnings to our shareholders. The goodwill associated with FEG and Terrill and our mortgage servicing rights were both subject to changes in market valuation and contributed to inconsistent earnings for us in past quarters.

  • My remaining slides, I've noted some highlights and challenges you'll see evident in our third-quarter numbers. On slide 10, you'll see that we improved our efficiency ratio for the third straight quarter at 60.6%, we continued toward our efficiency ratio target of 55% to 60%. I do want to point out that the third-quarter efficiency ratio was given a boost by a one-time benefit. We reversed $1.8 million in executive incentives that had been accrued through the second quarter. But offsetting this benefit however, was the fact we also had a full quarter's impact of expenses related to JW Flynn Insurance, the Company we acquired in May of 2005.

  • At this point in time, we really expect the efficiency ratio to stabilize in the near term unless we stand an appreciable increase in revenue. In our second-quarter call, I underscored our intent to reduce the size of our investment portfolio to between 25% to 30% of total assets by the end of 2005. On slide 11, you'll note we reduced the portfolio by $224 million on average during the quarter.

  • Even though this reduces net interest income in the short run, we believe strongly that this is an appropriate long-term decision. Based on period end numbers at September 30, our investment portfolio accounted for just under 30% of total assets. Shrinking our investment portfolio and increasing our average loans by $97.3 million during the quarter further improved our earnings asset mix.

  • Our improved earnings asset mix was a key contributor to the approved net interest margin for the quarter as you will note from the release in the information you received. Margin increased to 3.6% from 3.2% -- 3.26%, pardon me, from 3.2% in the second quarter. Not quite that good. Jim Ryan, our Treasurer, will provide us with more information on the factors that contributed to our third-quarter margin improvement and detailed some of our margin strategies as Lynell noted.

  • While we were pleased with our third-quarter performance I alluded earlier to the challenges we face looking forward. On my last slide, slide 12, I pointed out the issues that will really require our full attention in the fourth quarter 2005 and in 2006. Revenue grew less than $1 million during the third quarter and was virtually flat compared to third-quarter 2004.

  • Most obvious opportunity to improve revenue is to further increase our net interest margin. Increasing core deposits, particularly commercial checking balances is critical importance to us. Maintaining our recent pace of quality earning asset growth is also crucial.

  • In the near term, maintaining this pace of earning asset growth is challenging because of the reduction in our loan portfolio due to the Clarksville branch sale. Also, as we face the increases in short-term interest rates and the flattening of the yield curve that will likely persist into 2006, improving our net interest margin will be even more difficult.

  • Finally, I would just like to note that we built good processes around managing operating expenses and -- and these certainly will help ensure discipline in our expenditure decision. We have benefited from significant reductions in personnel and operating expenses over the last 18 months, and are not likely to be repeated at the same level in 2006.

  • So with that, I will turn the presentation over to Jim Ryan, the Company's Treasurer for further discussion of our net interest margin. Jim.

  • - VP & Treasurer

  • Thank you, Chris. On page 14, we are going to cover the shift and mix of earning assets. As Chris said earlier, we have been successful in shifting our earning asset mix more toward consumer and commercial loans. During the third quarter, total investments represented 33% of earning assets versus 34% at the end of the second quarter as shown on this graph. To further demonstrate that improvement total investments represented 37% just a year ago.

  • On slide 15, we are going to talk a little bit about the shift in the mix of core deposits. During the quarter, noninterest bearing demand deposits increased 1.8% and represented 14.5% of core deposits. Noninterest bearing deposits continued to increase as a percentage of earning assets and now represent nearly 11% of total earning assets.

  • Additionally, we saw customers shifting out of now and savings accounts into our higher yielding money market accounts. Money market accounts currently represent 13.5% of core deposits.

  • On page 16, we are going to talk about reduced reliance on borrowed funds. Borrowed funds continue to decline as a result of the smaller balance sheet. Borrowed funds average $1.8 billion during the third quarter versus $2.4 billion during the third quarter of 2004.

  • To reduce our sensitivity to rising rates, we have also terminated certain interest rate swaps that converted our borrowings to floating rate. Borrowed funds cost only increased 15 basis points during the third quarter versus a 45 basis point increase during the second quarter.

  • Slide 17, we like to cover our funding cost. The cumulative effect of 11 increases in the fed fund target rate since mid-2004 is pressuring core interest bearing deposit costs as shown on this graph. Core deposit decreased 20 basis points during the third quarter versus the increase of 15 basis points in the second quarter. The increasing cost is also a reflection of customer shifting deposits into the money market accounts out of now and savings accounts. Money market contracts more sensitive to short-term interest rates.

  • On slide 18, I would like to cover ongoing margin initiatives. The first slide covers balance sheet initiatives. We are going to continue to improve our earning asset mix. We are going to encourage floating rate loan production. As stated before, we've also offered customers who desire fixed rate loans, interest rate swaps, and will continue to do so. We are going to have an intense focus on low-cost deposit growth. We are going to continue to reduce our reliance on borrowed funds and improve the sensitivity to rising interest rates.

  • Slide 19 covers other initiatives we are working on that should improve the margin. We are centralizing our small business and corporate cash management function. We have made significant upgrades to our commercial internet banking platform and should be completed by year end. We are changing sales incentive plans to give more weight to new deposit accounts. We are going to reduce incentives when commercial loans are not directly tied to deposit accounts. And we are going to also develop more robust monthly performance metrics focused on low-cost deposit growth.

  • I would now like to turn the call over to Daryl Moore who will update you on the progress of strengthening our credit profile.

  • - EVP - Chief Credit Officer

  • Thank you, Jim. On page 21, you can see that nonaccrual loans at quarter end were $58.8 million, up $9.8 million from June 30th totals. The increase was due primarily to the addition of one significant commercial credit in our Indianapolis market that carried a balance of $8.7 million at quarter end. The addition of a large credit while it was not -- while it was not a surprise as we have been working with closely with the borrower for an extended time, nonetheless was disappointing.

  • To give you color on nonaccruals, at quarter end we had two nonaccrual accounts in the portfolio that had balances between $5 million and $9 million and only seven additional loans with balances in excess of $1million. The largest nonaccrual in the portfolio is the loan that we added this quarter.

  • The other area of contributing to the increase of nonaccruals was the retail lending area where nonaccruals rose $3 million in the quarter. This increase can be attributed almost entirely to the change in the bankruptcy laws which, as you know, became effective on October 17.

  • To give you an idea of the magnitude of the effect change in the bankruptcy law, American Bankers Association has reported consumer bankruptcy filings in Indiana in the second quarter were up over 25% from filings in the first quarter of 2005. These ABA statistics appear to be consistent with our experience in the most recent quarter which has led to increased nonaccrual balances in retail portfolio.

  • Just as a note, it is our policy to either charge off or place in nonaccrual all retail accounts when we receive a bankruptcy filing notice. Because of the flood of last-minute consumer bankruptcy filings we anticipate that both losses and nonaccruals in their retail area will show increases in the fourth quarter.

  • Allowance coverage of nonaccrual loans as shown on page 22, slipped to 138% at September 30 down from the prior quarter's 165% coverage level. As the allowance balance increased by $800,000 in the quarter, this slippage was due due entirely to the previously mentioned increase in nonaccruals.

  • Page 23 shows we continued our steady reduction of problem loans reducing problems or classified loans by $12.7 million or 8% in the quarter to a level of $145.8 million. Reductions in this category from the same date last year amounted to $122.5 million, representing a 45% reduction in loans in this category over that time period.

  • Total classified and criticized loans of September 30 were 248.7 million, down 6.1% from the 264 million at June 30, 2005 and significantly lower than the 473 million recorded September 30, 2004. One item of interest you may want to know is that we continue to reduce the total exposure of our largest 20 classified borrowers not in nonaccrual.

  • Exposer to this largest group is $53.5 million at September 30th. This compares to exposure at June 30 of $65.8 million and exposure September 30th of last year of $89.9 million. As I said in the past, we do continue to see progress made in the area of reducing classified and criticized loans. We have not yet been able to prove meaningful sustained reductions in our nonaccrual area.

  • We continue to work hard at identifying loans that are turning the wrong way early on in the cycle, so that they can be either rehabilitated in the short term or move out of the bank. This aggressive approach along with the already proven reduction in the risk of the classified and criticized categories should yield benefits in nonaccrual category, but the timing of that sustained reduction still uncertain, especially in light of the spike in nonaccruals and retail lending area that we expect from the fourth quarter due to the change in the bankruptcy law.

  • With that update, I will turning the call back over to Bob.

  • - President & CEO

  • Great. Thank you, Daryl. I am just going to close out with a few comments and then open it up for questions. We continue to be very pleased with the progress that we are making toward our ultimate goal of achieving consistent quality earnings.

  • On slide 25, you can see the targets that we set back in November of '04 for our -- for our long-term targets of 18 to 24 months. As you can see our tangible equity to assets ratio were within the range that we established on ROE on a basis of continuing operations we had an ROE of 13.64, again making good progress toward our ultimate goal of 18 to 24 months of 15 to 17%. Chargeoffs are within the range and as Chris noted our efficiency ratio took a nice turn to 60.6 and right at the top of the original target we set for efficiency ratio.

  • Also I want to highlight press release that we sent out on October 21, where we talked about two actions that our Board Compensation and Development Committee took, first as the establishment of stock ownership guidelines for the members of the executive leadership group. It began with requirement that I own five times my base salary and go to three times the base for the balance of the group, except for Mike Hinton, as our Chief Operating Officer who is required to own four times his base salary in addition we did establish ownership guidelines for our directors as well. Also in our release we noted the acceleration of our vesting of our stock options and we will be glad to take any questions that we might have on that.

  • I want to close with really reiterating what Chris said. While we remain confident for the estimates that are established for the fourth quarter in the range of estimates that are established for 2006, there are some continuing challenges. I am sure this isn't new news to you as you talk to other banks.

  • The margin compression will continue to put pressure on us as will the competition as we all battle for that asset and deposit growth. We do remain comfortable with the estimates as they are laid out, and we just reiterate what Chris said. A lot of activity occurred in the third quarter as we continue to take Old National to a platform for high performance.

  • - President & CEO

  • At this stage, we will be glad to open the lines for question.

  • Operator

  • Thank you. [OPERATOR INSTRUCTIONS] We will take our first question from Scott Siefers with Sandler O'Neill.

  • - Analyst

  • Hey, guys.

  • - EVP & CFO

  • How are you doing?

  • - Analyst

  • Good, how are you doing?

  • - EVP & CFO

  • Great.

  • - Analyst

  • A couple of quick questions for you. First, just trying to get my arms around how we could be thinking about the margin and net interest income going forward. I guess this is the first quarter in a while we didn't have a sequential decline in net interest income. Should we be kind of thinking that we sort of bottomed out there that continued mixed improvement might have any additional reductions in the size of the average earning asset balance. That will be number one.

  • And because we look at continued focus on efficiency. Do you see more opportunities to bring costs down on an absolute basis or do you think we kind of bottomed out in terms of where the run rate cost base is now?

  • - President & CEO

  • Let me cover the cost side and then I will let Jim Ryan cover the margin, because I've told him that is his single-most important job for us is to manage that margin. You know, we will not see the significant reduction in costs we have seen in the past. We do have a disciplined approach to managing costs. I think you will see a trend that is certainly not at the pace we were in the past. I wouldn't say we are at the bottom, Scott, I think there is still opportunity.

  • - Analyst

  • Okay.

  • - President & CEO

  • Let me turn it over to Jim.

  • - VP & Treasurer

  • On the margin front, I would classify our margin improvement strategy around making sure we have the most efficient asset base possible. While you may see earning assets go up, the mix of that earnings asset base is much more efficient and likely to lead to a stabilization of the margin. It is really centered around making sure that the earning assets we have are the best earning assets we could have in noninvestment.

  • - EVP & CFO

  • And Scott, this is Chris. I'll add, we are -- we did sell Clarksville obviously in the fourth quarter so that will have impact in the short run on our earnings asset base.

  • - Analyst

  • Okay. All right, thank you.

  • - President & CEO

  • Thanks, Scott.

  • Operator

  • And we will take our next question from Troy Ward with AG Edwards.

  • - President & CEO

  • Good afternoon, Troy, how are you doing.

  • - Analyst

  • Doing fine. Good afternoon.

  • - President & CEO

  • Too bad about your cardinals.

  • - Analyst

  • Oh, sure, rub it in. [ LAUGHTER ] Okay.

  • - President & CEO

  • You rub it in to us.

  • - Analyst

  • Hey, on -- on the insurance line item. I was looking for a pop this quarter related to the -- to the Indianapolis group coming on, and we actually saw a decline. Can you give me some color what happened there on the insurance item?

  • - EVP & CFO

  • Yes, I can, Troy, this is Chris. I think we had -- we had good growth there. I -- I don't have my numbers right in front of me, but there's a particular segment of their business called JWF -- and the rest of the accounting troop here is telling me that recall too last quarter we had significant contingency revenue in that quarter and that would have had an impact on our numbers second quarter to third quarter. That is absolutely right. And -- that's right.

  • - President & CEO

  • Troy, there was also a way -- the way they treated something as a revenue item we treated something as a contract expense, and that's little bit why they don't see that in one of their businesses.

  • - EVP & CFO

  • Troy, I will try to get you some more color on that.

  • - Analyst

  • Okay. First quarter we were about 9.1. I knew that was high because of some annual adjustments that you have. You are saying Q2 also had some -- some one-time --

  • - EVP & CFO

  • Yes.

  • - President & CEO

  • Yes. You know you have got the contingency that comes in that period of time. We don't have that benefit in the third quarter. Largest -- largest renewal period for our insurance group is in the first and second quarter, so that's where you will get your biggest pops.

  • - Analyst

  • So how should we look at this line item going forward? Is this a pretty good -- other than seasonal fluctuations, is this about where we expected to be?

  • - President & CEO

  • Yes, I would say that's right.

  • - Analyst

  • Okay. Can you go back, Daryl, and tell us, again, the amount of problem loans in your top 20 classified but not on nonaccruing?

  • - EVP - Chief Credit Officer

  • Sure, Troy. At the end of September, we were at $53.5 million. Those again are our largest classified loans that are not -- nonaccrual, and June 30, we were at $65.8 million, and if you go back a year September of 2004 we were at $89.9 million.

  • - Analyst

  • And those -- those are the top 20, the classified but not nonaccruing.

  • - EVP - Chief Credit Officer

  • That's right, the largest classified but not nonaccruing loan.

  • - Analyst

  • Great. One final -- you made the comment that you -- you -- you know, you had used the opportunity to move marginal loans or marginal credits out of the portfolio. To what extent does that happen, and -- and when you that, do you take a haircut on those?

  • - EVP - Chief Credit Officer

  • Well, what I was speaking about is for every -- for the top 15 largest criticized or classified loans in each one of our divisions that is on our list, you either have to from a lending perspective have it as an exit credit or it has to be a credit that we believe will be upgraded in the near term, and each of those relationship managers has to give us hurdles that their borrower has to meet over that near term or we make them an exit strategy. We are pushing our relationship managers to prove to us these will be upgraded. If not we get our special assets guys involved and gently push, if you will, these guys to other lenders.

  • - Analyst

  • But it is not where you are actually selling a whole loan. You are encouraging the customer to go elsewhere?

  • - EVP - Chief Credit Officer

  • That's right. From time to time we may have nonaccrual loans that we sell on a single one off or whole loan basis, but we don't have any intentions to go forward with any significant program to sell loans that are not in nonaccruals if that is what you are getting to.

  • - Analyst

  • Did you sell any loans this quarter that were not in nonaccrual.

  • - EVP - Chief Credit Officer

  • No, we did not.

  • Operator

  • We will take our next question from Fred Cummings with KeyBanc Capital Markets.

  • - President & CEO

  • Hi, Fred.

  • - Analyst

  • Hi Bob and all. Just a few questions here. First clarification, Chris. On the mortgage banking line item, did that include any servicing revenue this quarter? At $1.8 million?

  • - EVP & CFO

  • Yes. It would have included servicing revenue. The benefit from the sale was recorded in other revenue. So that would not have been in the mortgage banking line item, Fred.

  • - Analyst

  • How much -- what is the magnitude of the servicing revenue in that $1.8 million? Well, you can get back to me if you can.

  • - President & CEO

  • Based on the looks around the table, Fred, we will have to get to you with that answer.

  • - Analyst

  • All right. Moving secondly to loan growth, Bob. You guys had a very good quarter in commercial. Can you talk about where that is coming from, from a geographic basis?

  • - President & CEO

  • Yes, Fred, that is a great question. Obviously Indianapolis and Louisville continue to lead the pack. A couple of other markets came in nicely. Terre Haute being one of them which is not what you would consider a traditional growth market. So we will begin to see some of our other seven regions outside -- in the Indianapolis and Louisville, seen some loan growth.

  • - EVP & CFO

  • Particularly in consumables --

  • - President & CEO

  • He was talking about commercial.

  • - Analyst

  • Yes, I was going to get -- and I just wanted to -- the granularity of the commercial growth. You mentioned -- well Daryl mentioned one large loan went bad at $8.7 million in Indianapolis. In terms of the new loans you are booking, Bob, can you talk about types -- some of the loan sizes. Is this 2, $3 million credits. Are you still doing relatively large loans?

  • - President & CEO

  • We are nowhere near the size of loans we used to do, Fred. We're -- as we changed our focus, our loan size has come down. I would say average loan 1 to $3 million. Daryl can talk a little more about the types of credits, but, you know, we are pretty specific by industry and we have our watch industries and our loans that we focus on.

  • - Analyst

  • Okay. And then lastly, if someone can speak to the consumer portfolio growth. I wanted a better understanding of what is in that consumer growth, the $1.3 billion roughly, the mix between home equity and indirect auto.

  • - President & CEO

  • Chris --

  • - EVP & CFO

  • Yes, Fred. A lot of the growth we saw in the quarter was related to indirect auto. I do not have the breakdown between those two asset classes. At this point in time although I have just been handed a piece of paper that will -- that will help me tell what you that mix is -- [ LAUGHTER ] -- you know it -- it probably, you know, the consumer dealer component of those loans are probably about $500 million out of the total balance of a billion two. Less than 50%. But that's where we did -- we did get that growth in -- in the third quarter from -- we had -- we had growth in all components, but that was certainly where we saw the magnitude of growth.

  • - President & CEO

  • Mike, do you have anything you want to add to that?

  • - SEVP & COO

  • Chris is right. The biggest growth came in indirect, but close-in consumer mortgages, direct mortgages also had growth. Probably the lagging area is in revolving and credit, Fred. Our home equity lines just have -- have not been growing at the pace we would like to see them grow.

  • - Analyst

  • Yes. And, Mike, while you are -- while you are on, I have one last question. At the on-site, Mike, you talked about the goal of improving the cross-sell to 3.5 on the retail side. Can you give us some update as to what kind of progress you have made over the course of '05 here?

  • - SEVP & COO

  • Yes, Fred, I am going to wish that you had not remembered that. [ LAUGHTER ] We talked about 3.5, and I'm going to have to confess to you that we probably underestimated just exactly how difficult it was to move that overall average. We've actually moved the number up so that it's right at three services per household. That's -- that's an improvement of, I believe, about 8 basis points, and frankly, there is a whole bunch more elbow grease required to make that move than we anticipated when we started out.

  • - President & CEO

  • I think part of the challenge, Fred, is the MIS as we came into the process and the changes in the households presented -- maybe we were a little optimistic in saying we would get the 3.55.

  • - Analyst

  • Okay. Thank you.

  • - President & CEO

  • Thank you.

  • Operator

  • Once again as a reminder, it is Star 1 if you have a question or a comment and we will take our next question from Mark Kehoe with Merrill Lynch.

  • - President & CEO

  • Mark, how are you.

  • - Analyst

  • Good, how are are you.

  • - President & CEO

  • Good.

  • - Analyst

  • The first question I had was in terms of the loan that went bad. When was the loan originated?

  • - EVP - Chief Credit Officer

  • The loan was originally originated several years ago although we did -- within the last year extend some additional funds to that company, but the -- the customer hasn't been a customer for an extended time period.

  • - Analyst

  • Okay. The other question I had was, it's whether you will be able to grow earning assets over the next year of the security portfolio shrinks. My concern is that your earning asset base will decline. Meanwhile your margin will go up but overall earnings will fall. Can you address that issue please?

  • - VP & Treasurer

  • This is Jim Ryan. Our intent is to continue to reduce the size of the investment portfolio. Whether our loan growth will exceed that amount is yet to be determined, but nonetheless, I would think that we would see modest, maybe slightly down earning assets over the next few quarters.

  • - EVP & CFO

  • And, Mark, I think that is consistent with our interest rate risk, expectation in our rate outlook. We just feel in the long run it is a good decision to reduce the investment portfolio.

  • - Analyst

  • And a question for Bob. You have been there about a year now, restructuring the bank. How much more restructuring do you feel the bank requires?

  • - President & CEO

  • I would tell you nominal at best going forward. I think we've made our -- our key strategic decisions and sort of asset disposition. I think we are positioned in the markets we want to be positioned.

  • I think we are very comfortable with the plan we have laid forth. So a little bit of a -- a lot of action over the first three quarters. I think you will see a little less action, and it is really all now about execution as we go forward.

  • - Analyst

  • Just the last question. In terms of the option expense, what figures should we think of for next year for options?

  • - EVP & CFO

  • For option expense, you should have none, Mark. You know, we have accelerated those -- those options vesting. So there will be no expense associated with options in 2006.

  • - President & CEO

  • We don't issue options anymore.

  • - Analyst

  • Great, thank you.

  • Operator

  • And we will take our economics question with Charlie Ernst with Sandler O'Neill Asset Management.

  • - President & CEO

  • Hi, Charlie.

  • - Analyst

  • Good afternoon. Can you add a little detail to that other line? I think you said that there was some mortgage gain in there from the sale of the MSRs.

  • - EVP & CFO

  • Actually in the mortgage revenue, Charlie, there was not.

  • - Analyst

  • But in the other fee category.

  • - EVP & CFO

  • In the other -- pardon me, yes, about $450,000 --

  • - VP of IR

  • $200,000 net of tax.

  • - EVP & CFO

  • $200,000 net of tax. A relatively inconsequential amount given the cost of converting those mortgages and those kinds of things. Most importantly it was an opportunity for us to, you know, remove a problematic asset from our balance sheet.

  • - Analyst

  • The line looks to be, you know, up about, I don't know, a million, million and a half bucks in the quarter. Was there anything else lumpy in there that we should be thinking about?

  • - EVP & CFO

  • The other income line.

  • - Analyst

  • Yes.

  • - EVP & CFO

  • Yes. That in the -- in the second quarter of this year, we had an expense associated with the call of a retail trust preferred issuance. And the expense -- I believe it was $1.7 million, actually went into that number as a negative income item. The anomalies of our accounting, but, so, effectively, that really reduced that number in the second quarter a little unusually.

  • - Analyst

  • Have you gone through the calculation on the -- on the trump call to figure out how much of that benefit was a margin this quarter?

  • - EVP & CFO

  • I don't know that we looked at it specifically. It certainly -- it certainly was a lift though. As Jim indicated in his -- in his discussion on wholesale borrowing, I don't have an actual specific number for you, Charlie.

  • - Analyst

  • Okay.

  • - President & CEO

  • Charlie, we will get back to you on that.

  • - Analyst

  • Great. In terms of just helping us out with our models a little bit. Can you talk a little bit about the dynamics of Clarksville coming out -- of your income statement and the balance sheet?

  • - EVP & CFO

  • Yes. The -- out of -- there was approximately $115 million in loans coming out of the balance sheet at the sale, and about $170 million in deposits. The deposits were largely certificates of deposits although there were transaction accounts there too. Loans obviously are pretty critical.

  • You know we -- we -- in terms of an EPS impact, EPS impact, we'd estimate that was in the range of $0.01.5 to $0.02 a quarter. And not a number from a -- from a materiality standpoint that we don't expect we can overcome but certainly here in the near term in the fourth quarter, it is something we have got to deal with.

  • - Analyst

  • Okay. Great, thanks a lot, you guys.

  • - President & CEO

  • Thank you.

  • Operator

  • We will move next to John Rodis with Stifel Nicolaus.

  • - President & CEO

  • Good afternoon, John.

  • - Analyst

  • Good afternoon. How are you guys doing?

  • - President & CEO

  • We are doing great.

  • - Analyst

  • Bob, I guess in your guidance for '06, can you talk a little bit about the assumptions you are making as far as maybe what rates are going to do and the yield curve in general?

  • - President & CEO

  • Mike, Jim kind of covered that. Clearly we think rates are going to rise. And it is really a little too early in the process for us to give any guidance on any specifics other than that. It is our hope that the next call will give you a little tighter range of where we think we will end up in '06.

  • - Analyst

  • Okay. And what about the share buyback?

  • - President & CEO

  • That is a Board discussion that the Board has not approved anything for '06. And we have been authorized for 5%, and depending -- for '05, and depending on the opportunities, you know, we will just have to see what the markets bear.

  • - Analyst

  • Okay, thanks, guys.

  • - President & CEO

  • Thank you.

  • Operator

  • We will move next to David Konrad with Keefe, Bruyette & Woods.

  • - President & CEO

  • Hi, David.

  • - Analyst

  • Hi, good afternoon. A couple of questions just to follow up. Most everything was asked. But with regard to the impact of the Clarksville sale, with the gain of 14, 15 million, I guess that is pretax, I guess a follow-up comment to the share repurchase. We should -- accelerated share repurchase with the capital because it seems like you are in your target range to maybe offset some of that, the dilution impact.

  • - EVP & CFO

  • You know I think -- David, this is Chris. I think, you know, certainly in the context of our -- of our strategic initiatives here to really bring discipline back to the capital management process. We are looking at all of those things in concert. I think we also have to be sensitive, you know, to the price per share and the cash that we put to work when we were involved in a buyback. We bought back so far about 3.8% of the shares. There is no reason to think that we won't continue. We've been very consistent here through the year, but, I think we look at those opportunities all the time.

  • - Analyst

  • Okay. And then -- kind of another picture. I know it doesn't really impact year-to-date numbers, but we talked a little bit about the reversal of the -- of the employee accruals, the incentive accruals. Will it be fair to kind of -- if we look at trends year-to-date, would it be fair to maybe subtract out maybe $0.02 for this quarter and add back a penny in each of the previous quarters to kind of smooth out that accounting adjustment or am I thinking of that wrong?

  • - EVP & CFO

  • Well, you know, the challenge is you have the off70 the $2.2 million from Flynn, so --

  • - Analyst

  • That's kind of an ongoing business number, though, right?

  • - EVP & CFO

  • Yes. 13. Yes, I think you could say that number will be spread out over the quarter. How you divide it up, $1.8 million, and that was -- that was the accrual for the first two quarters.

  • - Analyst

  • Right. Right.

  • - EVP & CFO

  • So -- pretax basis, you know, actually talking about a penny, a penny a quarter.

  • - Analyst

  • Okay, great, thank you.

  • Operator

  • And this is a final reminder, Star 1 if you have a question or comment. We move to Karen Lamark [ph] with Merrill Lynch Investment Management.

  • - President & CEO

  • Karen, how are you.

  • - Analyst

  • Doing good. My apologies if you already answered this because I had to step out. But putting them all in that category. Can you give us a little more color, I guess on any regional concentration or industry concentration or is it kind of pretty broad-based and well representative.

  • - EVP - Chief Credit Officer

  • Karen, there is Daryl. On the 20 largest nonaccrual, is that what you are looking at?

  • - Analyst

  • Yes.

  • - EVP - Chief Credit Officer

  • Yes. I would say that as I look down this list, there really is no concentration on these top 20. They are pretty much as you would kind of expect if you would have a level and consistent underwriting process that -- it comes from each of our areas.

  • - Analyst

  • What is the most recent vintage or year that they were underwritten?

  • - EVP - Chief Credit Officer

  • Again looking down the list, virtually all of these loans were underwritten prior to the last 18 months which would be before we instituted our new underwriting policy.

  • - Analyst

  • Okay. And then going back to Mark's question about the ability, I guess -- I'll put it in the self-help category, how much restructuring is left. Is it fair to say then there is no real obvious leverage you can pull in terms of maybe cost opportunities, incremental cost opportunities or branch rationalizations or anything like that?

  • - President & CEO

  • You know, nothing that is obvious. Obviously as a matter of ongoing business, we look at all those opportunities but if you were looking for a big hunk of low-hanging fruit, I looked everywhere and I can't find anymore. So -- we have put in a very disciplined process around capital and expense management. We look for opportunities constantly but there's nothing, Karen, that just pops out and says you ought to build this into your models in the future.

  • - Analyst

  • Okay. Thanks for your thoughts.

  • - President & CEO

  • Thank you.

  • Operator

  • We will take our next question with a follow-up from Fred Cummings from KeyBanc Capital Market.

  • - President & CEO

  • Fred, if you get them all done the first time, it would make life easier for us.

  • - Analyst

  • I can't think that fast, Bob, you know that.

  • - President & CEO

  • That's 'cause you went to Oberlin.

  • - Analyst

  • Daryl, can you just give us a quick breakdown of the chargeoffs between commercial consumer, how that $5.3 million is broken out.

  • - EVP - Chief Credit Officer

  • I can, Fred. About a $1 million of that was -- this is on a net basis was it commercial -- And let me look here -- look here. The balance would have been -- well, about a million and a half in commercial and the balance would have been consumer. Okay, Daryl, are you attributing -- so you are attributing the -- assuming that was an uptick in consumer quarter-to-quarter, are you attributing that to the change in the consumer bankruptcy law? Yes --

  • - President & CEO

  • Yes, Fred. Our policy is such when you file bankruptcy, you go to nonaccrual.

  • - Analyst

  • Okay. And then I just had one last follow-up on the growth you are getting in indirect auto. That appears to be inconsistent with what at least I've seen from other banks. And I would imagine most of that is probably used car production. What would you attribute that pick-up too?

  • - President & CEO

  • You know really focus, Fred, you know we've put -- I guess an enhanced focus on our indirect business. Did some promotion work, and I think Mike has done a great job of getting people focused on the business. Mike?

  • - SEVP & COO

  • I think a big thing about that, too, Fred, is we have really concentrated and consolidated where we have done indirect underwriting and a couple of underwriting centers were -- they were very experienced and we have expanded them into other parts of our markets that -- where we were really not doing indirect lending. So we have had some good opportunities with picking up some new dealers. And we've been pretty aggressive in terms of how we set some pricing on indirect paper.

  • - Analyst

  • Okay. Now am I correct in assumes that most of that used as much cars.

  • - SEVP & COO

  • A combination but a lot of used cars and the greatest opportunity, you are right.

  • - Analyst

  • Thank you.

  • - EVP - Chief Credit Officer

  • Fred, this is Daryl. I gave you the wrong number. The $1 million, what I was looking at was for the month of September. I don't have the quarter in front of me but we will get back to you on that, but mix in September was about $2.5 million in total net loss, a million of it was commercial. A million and a half was consumer but we will get back to you with full-quarter numbers.

  • - Analyst

  • Okay, thank you.

  • - President & CEO

  • Thanks, Fred.

  • Operator

  • We will take a follow-up from Troy Ward with A.G. Edwards.

  • - Analyst

  • Hey, guys. Quick follow-up on the credit quality again. In the quarter it looked like you had a bit higher recovery than we have seen in -- in the previous quarters. And obviously which means net that there was higher chargeoffs as well. Daryl, how do you look at that going forward and do you think the gross chargeoffs can come down if the recoveries aren't there?

  • - EVP - Chief Credit Officer

  • You are absolutely right. We did have a significant -- fairly significant recovery on a loan that we took a loss on several years ago. I do think that depending on these two largest nonaccrual loans, we don't see a lot of losses going forward in the intermediate term outside those two. So I think we can feel pretty comfortable that the net losses are not going to be very volatile over the next several quarters.

  • - Analyst

  • Well, we have seen other than, you know -- if you exclude the 5.3 in Q2 related to the loan sales, you know, this is the third quarter in a row the gross chargeoffs have increased while that criticized bucket, you know, as you have seen in the slides continue to go in the right direction.

  • - EVP - Chief Credit Officer

  • Yes.

  • - Analyst

  • How frustrating is that? And when does that end?

  • - EVP - Chief Credit Officer

  • That is extremely frustrating.

  • - President & CEO

  • You think you are frustrated, Troy. How do you think I feel?

  • - EVP - Chief Credit Officer

  • And, Troy, you know, you always say in the banking business that you pay with losses a lot longer than you ever anticipate, well, we are past the time of even having -- being extra surprised on that. We just -- we just don't know. I would hope that it would be over the next several quarters, but in all honesty I cannot tell you because it has lasted a lot longer than what we had anticipated.

  • - Analyst

  • Do you think your chargeoffs in the next coming quarters will stay within your targeted range?

  • - EVP - Chief Credit Officer

  • They may be a little higher because of the increased consumer losses.

  • - Analyst

  • Okay, great, thanks.

  • - President & CEO

  • Thanks, Troy.

  • Operator

  • There are no further questions in our queue at this time. I will turn the call back over to Bob Jones for any closing or additional remarks.

  • - President & CEO

  • As always, if there are additional questions, feel free to call Lynell and she will connect you with the right person. Thanks again for your attentiveness and your great questions. We look forward to seeing you next quarter.

  • Operator

  • And this concludes Old National's call. Once again a replay along with a presentation slides have be available for 12 months on the shareholders relations page of Old National's web site at www.oldnational.com. A replay of the call will also be available by dialing 1-888-203-1112, confirmation code 8459444. This replay will be available through November 10th. If anyone has additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your presentation in today's conference call.